FEE INCOME: A STRATEGIC LEVER FOR DRIVING PROFITABILITY

WHILE MOST BANKS DO INVEST A FAIR BIT OF THEIR TIME AND ENERGY IN DEFINING THE FEES AND CHARGES WHEN NEW PRODUCTS GET DESIGNED AND ROLLED OUT, THE WHOLE AREA GENERALLY GETS IGNORED OR LEFT OUT WHEN IT COMES TO MEASURING EFFICACY – AS A RESULT, ONE ALWAYS FINDS ABOUT 20-30 PER CENT LEAKAGE OF THE FEES THAT OUGHT TO HAVE BEEN COLLECTED.

What is even more important is that having an effective fee income strategy, and focusing on having this well executed, has a direct and immediate impact on the profitability of the bank. Strategically speaking, should the fee income of the bank offset the operating expenses, the net interest margin could directly contribute to the profit. While the traditional ratio that is measured is that of fee income to the total income, there is an increasing trend to also measure the fee income as a ratio to the operating expense – the correlation to RoA is quite evident.

In a recent study that Cedar had executed, GCC banks were found to charge only about 65 per cent of the 200 categories of charges that global banks typically levy. While this may partly be attributed to the regulatory environment, as there are about 67 regulatory caps across various fee categories across GCC banks, it is also true that this area has not been truly explored by the regional banks effectively. As a matter of fact, the benefit of having the right fees may not just be an effective driver of profitability, but in many occasions, can also be a key customer segmentation differentiator, and potentially a positive experience driver.

A successful fee income strategy of a bank would essentially have three important aspects to it: the construct of the fee income model, the alignment to its customer segment, and the framework for continuous review. While each of them are independently important, the successful banks always find a way to have all of them well in place, as the absence of any of them will impact the value that the whole model can generate.

CONSTRUCT OF THE FEE INCOME MODEL

While traditional thinking is generally to relate fee income to that of a retail customer, it is quite commonplace now to see how corporate and commercial units leverage transaction banking space effectively, especially with a growing SME segment. A balanced approach to fee income strategy is to construct the model both for retail and corporate banking across three different layers:

  • Transaction: charges are mapped to services rendered – cash, cheque, remittances, standing orders, etc
  • Maintenance: charges that get levied for maintenance of account. Interestingly, while the product management functions of banks tend to be conscious of the fees and charges levied on the products and generally have upkeep, the leakage is most common in the transaction and maintenance related areas. The number of zero balance accounts that continue to exist with most banks is glowing evidence to this persistent issue.
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Fees and charges do have a function of elasticity inherently linked with it. For instance, a change of fees related to the SWIFT charges can be observed to directly impact the transaction behavior, reflecting very high sensitivity, especially that of the business banking segment to this fee category. Typically, the variance in the market pricing – between the highest charging bank and the lowest charging bank is the least for such charges. As a corollary to the above, one also sees charges related to PDC handling, cheque book issuance or inward remittances have a very high variance in market pricing, reflecting a low elasticity or sensitivity of the customer to that charge. Banks who have figured out this correlation well tend to reduce or waive the fees of charges that are highly sensitive, but make up for it in areas that have lesser elasticity.

ALIGNMENT TO CUSTOMER SEGMENT

Even while fees and charges get defined across products, transactions and maintenance charges, the differentiation to it’s application and alignment to the customer segments plays a very important role to drive positive customer experience.

While the segmentation right at the top starts with corporate, commercial/ business banking and retail, the key to driving the segmentation related fees successfully sits at the next level, which typically gets classified by the relationship value or is mapped to the focused demographic segments. Determining which fee has the highest elasticity will drive the maximisation of impact when the fee is waived off. For example, waiver of the account maintenance charge tends to have a relative higher impact in the mass affluent or priority segment, than what ones experiences in the elite or priority-banking segment. Fees and charges also serve as an effective tool for migrating customers from high cost to low cost channels, especially with banks where the alignment of channels to the customer segments is established well.

CONTINUOUS REVIEW FRAMEWORK

No matter how well the fees and charges are defined, unless these are continuously monitored for its efficacy, they tend to fall short of the expected results, as leakage invariably creeps in through the system. These may be due to incorrect definitions in the system, a waiver policy that allows for indiscrete changes to the structure, insufficient documentation – the list is endless. Having an effective and continuous review of fees collected well deserves a strategic oversight, given the direct and positive impact it has to the bottom-line.

A last word of caution before one embarks on an overhaul of fees income: defining the fee income model aligned to the segments is a science, but it is to be complemented by the art of customer communication. The benefits that accompany the service, for which the fees are charged, need to be highlighted before any new charge pops out on a customer statement. End of the day, the customer is quite sensitive to how well he is communicated, not just to what is being communicated!

Author | V. Ramkumar

For a further conversation on this subject of Cedar View or how we may be able to help please email V. Ramkumar, Senior Partner, Cedar at V.Ramkumar@cedar-consulting.com


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